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Measuring Value for Money

Good practice and common sense dictates that it is important to get good value from the money we spend and to optimise our return on investments. Assessing VfM is not easy nor is it straightforward.

Historically, particularly across many parts of the public sector, VfM has been managed through a ‘squeeze’ – ie progressive reductions in unit funding levels of 1 or 2% per annum. This approach does work but is a relatively ‘blunt’ instrument. It presumes that the sector is well funded initially, that all types of activity are equally 1 or 2% inefficient and can be ‘squeezed’ financially without too many detrimental effects. However, whilst the ‘1% reduction’ and similar approaches have early successes in driving down costs and driving up productivity, there is no evidence that the increased efficiencies have a positive impact on quality. Where it has been applied there is evidence that it has had a negative impact and reduced the capacity to cope with change or respond to ‘shocks’ or major changes in direction in the system.

More robust and fairer VfM measure(s) are needed to take greater account of the value delivered rather than just cost reduction. All sectors have attempted to develop VfM indicators. Over time these have progressed from relatively simple ratios to more complex calculations as the need for more complete, robust and fair indicators develop. The basic challenge is that, whilst the simple measures or ratios provide an indication of VfM, they affect the behaviour of the managers in the organisations being assessed. These individuals naturally attempt to optimise their performance indicators, but as the simple VfM indicators represent an incomplete model of the business, optimising the measure can generate significant ‘perverse’ results. For example, in retail, short term profit targets can be met by reducing sales staff levels but generating longer term reductions in customer service, potential loss of customers and increased recruitment and training costs to restore levels in the future. Similar examples have been seen in the public sector where over reliance on one measure has resulted in reductions in quality as well as costs, rather than increases in value for money.

Currently, the most well developed/advanced assessments in the private sector revolve around shareholder value and economic value added. Whilst these rely on the examination of historic data they also draw heavily on the assessment of likely future performance based on current management strategies. This assessment needs informed value judgements by individuals skilled as investment managers and knowledgeable in the organisation’s business activities.

This leads to an important message in how to assess VfM. Despite having indicators, all methods rely, in the final analysis, on professional judgement to interpret them. The indicators inform these judgements and support management in identifying areas where they can improve performance in the future. The VfM indicators in themselves are not fully definitive but highly informative.

So what types of VfM indicators are in use?

This blog is not long enough to detail all the different types of measures. I have picked out three major types of VfM indicators currently in use:

(1) Pricing ratios

These cover the cost or funding level per successful outcome or some form of output measure. For example, the cost per successful medical episode in the NHS.

(2) Performance over a range of indices

This often covers the three pillars of quantity, quality and costs of delivery and compares performance between organisations and over time to assess relative VfM. This can demonstrate improved VFM in one of three ways or a combination – for example:
• We are providing more widgets at the same quality and for the same total cost
• We are providing the same number of better quality widgets for the same price
• We are providing the same number of widgets at the same quality for a lower cost.

(3) Performance against plan

Here Value is described by the objectives of the organisation’s strategic plan. If the organisation meets its objectives within the agreed financial targets, then the organisation is regarded as providing good VfM. The approach relies on effective planning and performance review processes being in place that are sufficiently mature and robust to measure value as well as the monetary aspects of performance. There are however difficulties of interpretation, for example, when the organisation fails to meet its first year objectives, because of external factors but seems to be on track for the succeeding years. When do the stakeholders decide they are not getting value for money?

Whilst these are very different types of measures, they are not incompatible. It is often possible to use them in combination to inform the VfM assessment. For example, in assessing performance against plan, several indices might be used to set targets for performance. Some form of pricing measure might form part of the calculation of these indices. In addition, coupling them with other techniques such as the Kaplan Balanced Score Card approach to performance measurement can be very powerful. In addition many of the simpler measures might still be used at a variety of levels within an organisation providing that there is a clear rationale for the simpler measures and some link can be deduced between them and overall assessment. However, to arrive at a comprehensive understanding of VfM a more complete model of the business/activity has to be used for the assessment.